The Crimson Press Curriculum Center

First Page and the Assignment Questions:
We had to do something different. The company was doing great according to all the performance indicators we monitored, and our managers were earning nice bonuses, but the share owners weren't benefiting.
   —William Embleton

William Embleton, managing director of Berkshire Industries PLC, explained why his company had implemented a new incentive system based on an “economic profit” measure of performance starting in the year 2000. In 2002, however, Berkshire managers were questioning whether their new system had had its desired effects. The new economic profit measure did not seem to be any better in reflecting share owner returns than did the old measure-accounting earnings-on which Berkshire managers had previously focused. And the new system was causing some management confusion and a perceived unfairness issue. Mr. Embleton had to decide whether to modify the new system, and if so how, or to replace it with something else.

THE COMPANY

Berkshire Industries PLC (Berkshire) was founded in 1852 as a brewery serving local pubs. Over the years it had grown, both internally and by acquisition. In 2002, Berkshire was a medium-sized, publicly held corporation focused on the beverages and snack foods industry. It had annual turnover of about £500 million and it employed nearly 3,500 people in six countries. Berkshire was listed on the London Stock Exchange. The company headquarters was still located in Manchester, England, where the company was founded.

Berkshire had four operating divisions: beer, spirits, soft drinks, and snack foods. The managing directors of each of these divisions had considerable autonomy because Berkshire operated in a decentralized fashion. The small headquarters staff was primarily responsible for coordinating the finance, human resources, and various administrative functions (e.g., legal, information systems).

MEASUREMENT AND INCENTIVE SYSTEMS

Since the company had gone public, the primary performance emphasis at Berkshire had been on corporate earnings per share (EPS). The company's long-term EPS growth target was 8%, but the target was modified each year based on anticipated market conditions and pending acquisitions, if any.

The company's annual planning process was a bottom-up process, which first involved the operating divisions proposing their earnings targets for the year and their means of achieving them. The division's draft plans were consolidated and compared with Berkshire's corporate EPS growth target. Typically the difference between the divisions' plans and the corporate target was material. This “planning gap” was eliminated in a series of discussions among corporate and division managers, typically by increases in some or all divisions' targets.

Assignment

1.   Were Berkshire's motivations for a new incentive system reasonable? If so, what were their main options for a new system? Was an economic profit-focused system a reasonable choice?

2.   Use the data pertaining to the Snack Food Division, as shown in Exhibit TN-1, to calculate:
a.   The economic profit for the division for 2000 and 2001
b.   The economic profit target for the division for 2001
c.   The division manager's bonus payout (% of salary) for 2000 and 2001. (Assume that the slope of the payoff line for 2000 was arbitrarily set by Berkshire management to equal 1.0.)

3.   Assume the base salary of the manager of the Snack Foods Division was £120,000 in both 2000 and 2001. How much cash would the manager receive from his bonus payouts in 2000 and 2001?

4.   Evaluate the Berkshire Industries' new incentive plan. What changes would you recommend, if any?

5.   Should Mr. Embleton make special adjustments of the economic profit figures or the bonus payouts for personnel in the Spirits Division in 2000 and 2001? Why or why not?